Chapter 7 The Conversion Cycle
manufacturing process
Most apparent in manufacturing firms, review of the
traditional batch production model examines
manufacturing techniques and technologies in
world-class companies.
Philosophy of Lean Manufacturing
 evolved from the Toyota Production System
(TPS)
 Purpose : to improve efficiency and
effectiveness in product design, supplier
interaction, factory operations, employee
management, and customer relations
 Key to success : achieving manufacturing
flexibility
Manufacturing Flexibility
 physical organization of production
facilities
 employment of automated technologies
a) computer numerical controlled (CNC)
machines,
b) computer integrated manufacturing
(CIM)
c) automated storage and retrieval
d) systems (AS/RS)
e) robotics
f) computer-aided design (CAD)
g) computer-aided manufacturing (CAM)
 Examines problems associated with
applying standard cost accounting
techniques in a highly automated
environment.
 The key features of two alternative
accounting models are discussed:
(1) activity-based costing (ABC)
(2) value stream accounting
 Discussion of the information systems
commonly associated with lean
manufacturing and world-class companies
a. Materials requirements planning
(MRP) systems
 to determine how much
raw materials are required
to fulfill production orders
The Traditional Manufacturing Environment
 The conversion cycle consists of
o physical activities
o information activities
 The Production system. Involves the
planning, scheduling, and control of the
physical product through the
 Production is triggered by customer orders
from the revenue cycle and or by sales forecasts
from marketing
 Inputs trigger:
 set a production target
 prepare a production plan
 Purchase requisitions(purchases
procedures), Labor (payroll),
Manufacturing costs WIP & FG (GL &
FS)
 Production methods {depende sa product na
immanufacture mo}
1. Continuous processing - homogeneous product
(cement)
2. Make-to-order processing
 discrete products
 initiated by sales orders rather than
depleted inventory levels
3. Batch processing
 Each item in the batch is similar
 most common (cars, household appliances,
canned goods, tires, and books)
BATCH PROCESSING SYSTEM
 batch processing system, which consists of
four basic processes
1. plan and control production
2. perform production operations
3. maintain inventory control
4. perform cost accounting
Documents in the Batch Processing System
1. Production schedule
 formal plan and authorization to begin
production
 describes the specific products to be made,
the quantities to be produced in each batch,
and the manufacturing timetable for
starting and completing production
2. Bill of materials
 specifies the types and quantities of the raw
material (RM) and subassemblies used in
producing a single unit of finished product
o RM requirements for entire
batch = BOM x number of items
in the batch
3. Route Sheet
 shows the production path that a
particular batch of product follows
during manufacturing
 sequence of operations (machining or
assembly) & standard time to each task.
4. Work order (or production order)
 draws from BOMs and route sheets to
specify the materials and production
(machining, assembly, and so on) for
each batch. These, together with move
tickets (described next), initiate the
manufacturing process in the
production departments.
5. Move Ticket
 records work done in each work center
and authorizes the movement of the job
or batch from one work center to the
next.
6. Materials Requisition
 authorizes the storekeeper to release
materials (and subassemblies) to
individuals or work centers in the
production process
 specifies only standard quantities
 separate requisitions - Materials needed
in excess of standard amounts require
this
 less than the standard amount material
is used, the work centers return the
unused materials to the storeroom
accompanied by a materials return
ticket
Batch Production Activities
 Production Planning and Control
o Materials and operations
requirements
o Production scheduling
 Materials and Operations Requirements
o Materials requirement – the
difference between what is needed
and what is available in inventory
o Operations requirements – the
assembly and/or manufacturing
activities to be applied to the
product
 Production Scheduling
o Coordinates the production of
multiple batches
o Influenced by time constraints,
batch size, and other specifications
 Work Centers and Storekeeping
o Production operations begin when
work centers obtain raw materials
from storekeeping.
o It ends with the completed product
being sent to the finished goods
(FG) warehouse .
 Many organizations today, however, make
this data transfer digitally via computerized
systems that use data entry screens or
capture data by scanning bar code tags
 we examine three of the four conversion
cycle processes
1. PRODUCTION PLANNING AND CONTROL-
consists of two main activities:
 Specifying Materials and Operations
Requirements.
 RM requirement for a batch = Inventory
Need – Inventory Available
 info comes from analysis of
inventory on hand, the sales
forecast, engineering specifications
and BOM
 operations requirements for the batch
involve the assembly and/or manufacturing
activities that will be applied to the product
 determined by assessing route
sheet specifications.
2. PRODUCTION SCHEDULING
 master schedule for a production run
coordinates the production of many
different batches
 influenced by time constraints,
batch size, and specifications
derived from BOMs and route
sheets
 produces work orders, move tickets, and
materials requisitions for each batch in the
production run
 copy of each work order is sent to
cost accounting to set up a new
work-in-process (WIP) account for
the batch
 enter the production process and
flow through the various work
centers [in accordance with the
route sheet]
3. WORK CENTERS AND STOREKEEPING
 The actual production operations begin
when workers obtain raw materials from
storekeeping in exchange for materials
requisitions
 M,L, MOH – applied according to work order
 When the task is complete at a particular
work center, the supervisor or other
authorized person signs the move ticket,
 which authorizes the batch to proceed to
the next work center
o FOR EVIDENCE : copy of the move
ticket is sent back to production
planning and control to update the
open work order file (ma-cclose ito
kapag nareceive na ang last move
ticket)
o The finished product along with a
copy of the work order is sent to
the finished goods (FG) warehouse
o copy of the work order is sent to
inventory control to update the FG
inventory records.
 Work centers also fulfill an important role
in recording labor time costs.
o is handled by work center
supervisors who, at the end of
each workweek, send
 employee time cards to
payroll departments
 job tickets to cost
accounting departments
INVENTORY CONTROL
 OBJECTIVE : to minimize total inventory cost
while ensuring that adequate inventories
exist to meet current demand
 consists of three main activities
 provides production planning &
control with status reports on FG
and RM inventory.
 continually involved in updating
the RM inventory records from
materials requisitions, excess
materials requisitions, and
materials return tickets
 upon receipt of the work order
from the last work center,
inventory control records the
completed production by updating
the finished goods inventory
records.
 Inventory models used to achieve objective
help answer two fundamental questions:
1. When should inventory be
purchased?
2. How much inventory should be
purchased?
ECONOMIC ORDER QUANTITY (EOQ) MODEL
 OBJECTIVE: to reduce total inventory costs
 is based on simplifying assumptions that
may not reflect the economic reality
1. Demand for the product is constant & known with
certainty.
2. The lead time is known and constant.
 the time between placing an order for
inventory and its arrival
3. All inventories in the order arrive at the same
time.
4. The total cost per year of placing orders is a
variable that decreases as the quantities ordered
increase.
 Ordering costs include the cost of preparing
documentation, contacting vendors,
processing inventory receipts, maintaining
vendor accounts, and writing checks.
5. The total cost per year of holding inventories
(carrying costs) is a variable that increases as the
quantities ordered increase.
 These costs include the opportunity cost of
invested funds, storage costs, property
taxes, and insurance.
6. There are no quantity discounts
 Therefore, the total purchase price of
inventory for the year is constant.
 significant parameters in this model are
the carrying costs and the ordering
costs.
o Parameters – sets the
conditions of its operation.
o Pag mas marami ang order mo,
mabawasan ang times na mag
order ka, bale yung annual
ordering cost mo ay
mababwasan
o pagmas marami ang order mo,
mas marami kang inventory on
hand, bale magtaas yung
annual inventory carrying cost
mo
o Dahil yung PURCHASE price
natin ay constant, ang gagawin
natin ay babawasan ang
ordering cost at carrying cost.
Where: Q = economic order quantity
D = annual demand in units
S = the fixed cost of placing each order
H = the holding or carrying cost per unit per
year
When do we purchase?
Reorder Point (ROP)
ROP = Lead time x Daily Demand
Daily Demand = Total Demand/number of working
days
 If the parameters DAILY DEMAND and
LEAD TIME are stable
 organization should receive the
ordered inventories just as the
quantity on hand reaches zero
 If either or both DAILY DEMAND and LEAD
TIME are subject to variation
o additional inventories called safety
stock must be added to the reorder
point to avoid unanticipated
stockout events.
 Stock-outs result in either lost
sales or back-orders.
 back-order is a customer order
that cannot be filled because of a
stock-out and will
remain unfilled until the supplier
receives replenishment stock
 When an organization’s inventory usage
and delivery patterns depart significantly
from the assumptions of the EOQ model,
more sophisticated models such as the
back-order quantity model and the
production order quantity model may be
used.
Cost Accounting Activities. Cost accounting activities
of the conversion cycle record the financial effects of
the physical events that are occurring in the
production process.
CONTROLS IN THE TRADITIONAL ENVIRONMENT
 Transaction authorizations
o work orders – reflect a legitimate
need based on sales forecast and
the finished goods on hand
o move tickets – signatures from
each work station authorize the
movement of the batch through the
work centers
o materials requisitions – authorize
the warehouse to release materials
to the work centers
 Segregation of duties
o production planning and control
department is separate from the
work centers
o inventory control is separate from
materials storeroom and finished
goods warehouse
o cost accounting function accounts
for WIP and should be separate
from the work centers in the
production process
 Supervision
o work center supervisors oversee
the usage of raw materials to
ensure that all released materials
are used in production and waste is
minimized
o employee time cards and job
tickets are checked for accuracy
 Access control
o direct access to assets
 controlled access to
storerooms, production
work centers, and finished
goods warehouses
 quantities in excess of
standard amounts require
approval
o indirect access to assets
 controlled use of materials
requisitions, excess
materials requisitions, and
employee time cards
 Independent verification
o cost accounting reconciles material
usage (material requisitions) and
labor usage (job tickets) with
standards
 variances are investigated
o GL dept. verifies movement from
WIP to FG by reconciling journal
vouchers from cost accounting and
inventory subsidiary ledgers from
inventory control
o internal and external auditors
periodically verify the raw
materials and FGs inventories
through a physical count
World-Class Companies and Lean Manufacturing  Inefficiencies in traditional plant layouts
increase handling costs, conversion time,
 continuously pursue improvements in all and excess inventories.
aspects of their operations, including  Employees tend to feel ownership over
manufacturing procedures their stations, contrary to the team concept.
 are highly customer oriented  Reorganization is based on flows through
 have undergone fundamental changes from cells which shorten the physical distance
the traditional production model between activities.
 often adopt a lean manufacturing model o This reduces setup and processing
time, handling costs, and
Principles of Lean Manufacturing inventories.
 Pull Processing – products are pulled from Automating Manufacturing
the consumer end (demand), not pushed
from the production end (supply)  Traditional Approach to Automation
 Perfect Quality –pull processing requires  Consists of many different types of
zero defects in raw material, WIP, and FG machines which require a lot of
inventories setup time
 Waste Minimization – activities that do not  Machines and operators are
add value or maximize the use of scarce organized in functional departments
resources are eliminated  WIP follows a circuitous route
 Inventory Reduction – hallmark of lean through the different operations
manufacturing  Islands of Technology
 Inventories cost money  Stand alone islands which employ
 Inventories can mask production computer numerical controlled (CNC)
problems machines that can perform multiple
 Inventories can precipitate operations with less human
overproduction involvement
 Production Flexibility – reduce setup time to  Computer Numerical Controlled (CNC )
a minimum, allowing for a greater diversity Machines
of products, without sacrificing efficiency  Reduce the complexity of the
 Established Supplier Relations – late physical layout
deliveries, defective raw materials, or  Arranged in groups and in cells to
incorrect orders will shut down production produce an entire part from start to
since there are inventory reserves finish
 Team Attitude – each employee must be  Need less set-up time
vigilant of problems that threaten the
continuous flow of the production line  Computer Integrated Manufacturing
(CIM)
 A completely automated
Lean Manufacturing Model environment which employs
automated storage and retrieval
 Achieve production flexibility by means of: systems (AS/RS) and robotics
 Changes in the physical organization of  Automated Storage and Retrieval Systems
production facilities (AS/RS)
 Employment of automated technologies  Replaces traditional forklifts and
 CIM, AS/RS, robotics, CAD, and their human operators with
CAM computer-controlled conveyor
 Use of alternative accounting models systems
 ABC and value stream  Reduce errors, improved inventory
accounting control, and lower storage costs
 Use of advanced information systems  Robotics
 MRP, MRPII, ERP, and  Use special CNC machines that
EDIturing Model are useful in performing
hazardous, difficult, and
Physical Reorganization of the Production Facilities monotonous tasks
  Computer-Aided Design (CAD)
 Increases engineers’
productivity
 Improves accuracy
 Allows firms to be more
responsive to market demands
 Interfaces with CAM and MRPII
systems
 Computer Aided Manufacturing (CAM)
 Uses computers to
control the physical
manufacturing process
 Provides greater
precision, speed, and
control than human
production processes

What’s Wrong with Traditional Accounting

Information?

 Inaccurate cost allocations – automation

changes the relationship between direct
labor, direct materials, and overhead cost

 Promotes nonlean behavior – incentives to

produce large batches and inventories, and
conceal waste in overhead allocations

 Time lag – data lag due to assumption that

control can be applied after the fact to
correct errors

 Financial orientation – dollars as the

standard unit of measure

Activity Based Costing (ABC)

 is an information system that provides

managers with information about activities
and cost objects

 assumes that activities cause costs and that

products (and other cost objects) create a
demand for activities

 is different from traditional accounting

system since ABC has multiple activity
drivers, whereas traditional accounting has
only one, e.g. machine hours